The Economics of Kaesong

Ruediger Frank, in his February 12 article on38 North, opines that in closing the Kaesong Industrial Zone (Kaesong or KIZ), South Korea may have “shot itself in the foot.” I beg to differ, sharply. Closure might not change North Korea’s nuclear and missile development, but it can open the door to reform driven by the continued slow-motion collapse of North Korea’s command economy, of which, Kaesong has been an integral part. Furthermore, as a reformed economy is probably the only thing that will convince Kim Jong Un to quit his nuclear ambitions, we should make all efforts to encourage economic reform in North Korea.

(Photo: AP)

First, and a minor point, Frank appears to exaggerate the data, stating that Kaesong’s $100 million in annual income to the North Korean state is equivalent to only one percent of the country’s total trade volume. That says North Korean foreign trade equals about $10 billion a year, which seems rather high. Just released data from China indicates that North Korean trade with China in 2015 amounted to about $5.4 billion (plus about $600 million in free crude oil no longer included in the official statistics) and that is most of North Korea’s trade.[1] But why even compare the government’s income from Kaesong to the total volume of trade? Aside from the crude oil, North Korean exports and imports are nearly in balance given the country’s lack of credit and small amount of aid receipts, so any loss of income translates directly into the loss in the state’s ability to buy what it needs. In that respect, $100 million a year is not a small amount. It is twice the amount spent on Chinese computer related imports, for example, and six times the amount spent on Chinese grain imports.[2]

Much more important is the role that Kaesong has played in keeping alive the state enterprise or command economy system. It follows a long list of West European, Japanese and even American projects putatively aimed at helping North Korea transform its economy, but which instead have helped it degenerate into the mess it is today. Feeding the state these foreign interventions has allowed Pyongyang to muddle along without allowing an efficient private export industry to develop, something terribly needed by the people so they can earn money to feed and support themselves. I’m pretty sure if China had been the recipient of such largess, it also would not have reformed along Deng Xiaoping’s lines in the 1980s.

The specific economic problem with Kaesong is that the 54,000 workers there have never been paid in real money; instead, they have been provided rations from the state agency that manages the project. Most outsiders don’t seem to understand this since the wages are negotiated in US dollars (about $75 a month plus a large amount of overtime) and the South Korean firms pay this to the state agency. The workers get a portion, but as exchanged at the official rate of about 170 North Korean won per dollar, instead of the market rate of about 8,000 won per dollar—mere lip service to UN labor rules that say workers must be paid directly. So even if the worker received the entire dollar amount of her wage, her buying power would equate to only about two kilograms of rice a month in the Kaesong market. Or maybe $5.00. Even in North Korea, this is nothing. No money circulates to employ other people in the village, encourage private activities, or to save and invest—a perfect solution for Pyongyang’s otherwise frustrated and scarred central planners. Of course, the socialist system is supposed to provide every worker a food ration, free housing and education, and health care for what it is worth, so they may not need money to survive. And South Korean managers often provide perks unavailable in domestic factories, which the workers sell in the markets for a little pocket money.

In my view, the only correct way to describe such an employment system is slavery. One definition of slavery might be a system in which workers are not paid directly, lest money give them the power to become independent of their employer. The women of Kaesong have none of the economic power that real wages would provide. They work difficult jobs far from their families, are bused often at long distances from their dormitories, and are rotated out every several years. They can be fired at the whim of their Workers’ Party bosses. How can this be a good experience for them? And how can the rest of the world countenance this kind of state behavior? An American analogy might be British support for Southern cotton plantations prior to the Civil War amid suggestions that this was good for the slaves since it supported their employment.

So what will become of the 54,000 workers suddenly let go from Kaesong? They will be sent back to their family homes, but I suspect they will not fare much worse. Fortunately, a new phenomenon is occurring in North Korea as a result of the drying up of Western and South Korean aid—Pyongyang is being forced to allow private activities that generate foreign exchange earnings. The May 30, 2013 administrative measures, for example, allowed some pilot exporting firms to pay workers up to 300,000 won per month, 100 times the ordinary fixed wage schedule paid by state enterprises, in a bid to increase export goods production.[3]

In real terms, this is still a small wage but a livable one even completely apart from the command economy, and one that seems to be catching on. I suspect small Korean-Chinese investors are the ones taking advantage, employing many workers similar to those employed in Kaesong but in old decrepit factories in industrial North Korean cities. I don’t know how well these pilots are working, but North Korean exports of the kinds of things such factories produce—textiles for example—have increased in the last couple of years, and markets of all kinds seem to be expanding rapidly.

Amazingly, US dollars now flow freely within the economy. This comes at a big cost to state enterprises which are funded in won or are supplied directly through the central plan. The state enterprises are suffering loss of workers and material support with devastating impact on the important services they normally provide, such as electricity, rail transportation and the products of heavy industry. The military has high priority but even it is not immune from state resource constraints and increasingly has to earn dollars to compete for resources from the private sector. This is why the Kaesong dollars are so important. Hopefully, with the closure of Kaesong, North Korean authorities will have to expand the export earning pilots, maybe to Kaesong itself, or even throw out the socialist wage system. A new deal in which Kaesong is reopened with direct pay to workers and a reasonable tax cut for the state would signal real economic reform and should be welcomed by all sides.